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Cents and Sensibility Guy Steele |
New rules make it less
costly to tap into your IRAIf you've been making withdrawals from your "traditional" IRA before you reached 59 1/2, then you've had to follow some strict rules, even if they forced you into depleting your account far more than you liked. But now, the IRS has loosened things up a bit, and that means you've got some flexibility.
Before we look at the rule changes, let's quickly review how you can take money from your IRA in the first place.
If you withdraw funds from your IRA before you reach 59 1/2, you have to pay a 10 percent penalty. However, under Section 72(t) of the U.S. tax code, you can avoid this fine if you take what's known as "substantially equal periodic payments" for five years or until you reach age 59 1/2, whichever takes longer.
The actual amount of money you receive depends on the withdrawal method you choose. The IRS allows you to select from either two different fixed withdrawal methods -- which means you have to take out the same amount of money every year -- or a variable withdrawal method -- which means the amount of your withdrawal varies, based on the changing value of your IRA. Until recently, you couldn't make changes after you chose a withdrawal method. So, for example, if you took fixed withdrawals, and you decided to start taking out less, then the 10 percent penalty would be applied retroactively to every dollar you had taken out of your IRA since starting systematic withdrawals.
Why would you change your mind? Just look at your IRA balance. A few years ago, when we were in a strong bull market, you might have thought you could easily afford to take out a certain amount of money from your IRA every year. Now, after a few down years for stocks, your IRA has probably suffered, and that same fixed amount you keep taking out represents a much bigger percentage of your remaining balance. Consequently, if you were forced to keep withdrawing the same amount each year, you could come close to wiping out your IRA altogether.
Fortunately, you've got an escape route. The IRS now permits you to slow down your IRA withdrawals by switching from a fixed withdrawal method to the variable withdrawal alternative. And you won't be slapped with the 10 percent penalty. If you move to the variable method, you can choose to have your withdrawals based on either your life expectancy or the joint life expectancy of you and your IRA beneficiary, such as your spouse or child. If your goal is to reduce your IRA withdrawals as much as possible, you may elect the "joint life expectancy" option. By spreading out the total amount withdrawn over two life expectancies, you can take out less in individual withdrawals.
Clearly, the IRS ruling gives you more flexibility if you're going to make IRA withdrawals before you reach 59 1/2. Of course, the new rules, by themselves, shouldn't be the determining factor in whether you make early withdrawals. Generally speaking, you're probably better off delaying IRA withdrawals for as long as you can. Before you make any decisions, consult with your tax adviser. Your IRA is an important source of retirement savings, so use it wisely.
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Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com